At its core, our investment philosophy is all about gaining exposure to secular trends. An increase in healthy eating habits? Whole Foods (WFM) is the way to go. Growth in spectrum demand? Clearwire (CLWR) is the way to leverage it. And Big Data? For many, companies such as EMC are the natural answer. But, in this article, we would like to highlight an under the radar company that has inserted itself into middle of the big data market, and it is one that we believe has the potential to deliver investors solid returns. And that company is Attunity (ATTU).
Attunity is an Israeli based technology company (its American headquarters are in Burlington, Massachusetts) that sells several different data products. The company's core products are Attunity Replicate, which allows customers to quickly and easily duplicate and distribute data across their corporate infrastructure, and Attunity CDC (change data capture), which allows customers to capture and stage "only the changes that have been made to enterprise data sources." Attunity is growing on all fronts; it is expanding its customer and partner base, and in our view, it is well positioned for future success. For the record, unless otherwise noted, financial statistics and operational facts (such as recently won deals) will be sourced from the company's Q3 2012 earnings release.
Q3 2012: Growth and Customer Wins, and Positive Guidance
Attunity posted its results for the third quarter of 2012 on October 31. Revenues grew by 72% to $5.936 million, up from $3.451 million the year before. Operating income came in at $569,000, as compared to an operating loss of $407,000 the year before (For Q3, the company's GAAP operating margin was 9.59%, more on that a bit later). On a GAAP basis, net income was $43,000 in Q3 2012, or $0.00 in EPS (due to the effects of rounding).
On a pro forma basis, operating income grew by 60.16% to $993,000, from $620,000 a year ago. Attunity's income growth failed to keep pace with revenue growth due to 2 key factors: a surge in R&D spending, and a surge in marketing costs. Year-over-year, R&D spending jumped by over 63% to $1.899 million, while sales & marketing costs jumped by 60.76% to $2.151 million. But, we view these as bullish signs. Attunity is investing for growth, and is spending needed money on developing new products, as well as building out its sales force and marketing operations.
In time, as the business scales out, we expect sales & marketing expense growth to slow, which will bring about a boost in margins. On a pro forma basis, Attunity's Q3 2012 operating margin was 16.73%, compared to 17.97% a year ago. In the technology sector, many companies sacrifice their margins in the pursuit of growth. While Attunity's margins did drop in its latest quarter, a drop of 1.24% is not as large as what we have seen from some other technology companies, and we believe that in the long-term, Attunity's margins will not only rebound to 17.97%, but will expand past that as the company scales its business.
Even though the third quarter is Attunity's slowest, due to seasonal effects (revenues grew by over 110% in Q2, compared to 72% in this latest quarter), that did not stop the company from expanding its customer base, and integrating itself further into the data sector. During this quarter, Attunity released Attunity Replicate for Oracle's (ORCL) Exadata databases, as well as for EMC's Greenplum systems. The company also inked a deal with Teradata (TDC) to utilize Attunity Replicate in Teradata's warehouses. But, Attunity focused on more than just expanding the partner list for its products during the quarter. The company signed several major customers in Q3 2012, including a major European bank, a large telecommunications company in Japan, and it expanded its product portfolio for use in Amazon's (AMZN) Web Services.
The company's momentum is building, and it is why Attunity believes that Q4 2012 will be a record quarter in terms of both revenues and profits. Unlike many high-growth companies that sacrifice profits for growth, Attunity is working to find a proper balance between the two. The company's revenue growth is over 70%, and yet the company is still profitable, on both a GAAP and non-GAAP basis. And we expect those profits to rise as Attunity continues to expand its customer base. Attunity's customer list now includes companies such as HSBC (HBC), Sprint (S), AK Steel (AKS), Chevron (CVX), Cisco (CSCO), ExxonMobil (XOM), and GE. Attunity is also expanding its presence into the public sector; its products are now in use by the F.A.A., the Department of the Treasury, and the Department of Homeland Security.
Financials & Valuation
Attunity's balance sheet contains $1.714 million in cash & equivalents, and no interest-bearing debt. Its most notable liability is $3.742 million in accrued severance pay, but $2.74 million of that has already been set aside. And as Attunity's revenues and profits continue to rise, the company's balance sheet will strengthen. From a debt-equity standpoint, Attunity's leverage ratio currently stands at 1.89x, down from 3.43x a year ago. However, that leverage ratio is, in our view, overstated.
Of the $15.308 million in total liabilities on the company's balance sheet, deferred revenue accounts for $4.835 million of that total. And another $1.867 million of the company's liabilities is in the form of a contingent payment obligation to RepliWeb shareholders, which will be paid out only if the company meets certain business milestones, per Attunity's latest 20-F filing. If RepliWeb meets those milestones, we doubt that Attunity will have an issue in meeting that obligation.
In Q3 2012, Attunity burned $620,000 in operating cash flow (calculated by reconciling its Q3 2012 earnings release with its Q2 2012 earnings release). However, this was due to changes in working capital, as the company elected to pay down a number of accrued expenses. Cash flow was also impacted by accounts receivable collections. In Q3 2012, accounts receivable rose by $634,000, and while this will be an issue to watch in the quarters to come, we do not think that it will have a material impact on the company's business going forward.
We turn now to the subject of Attunity's valuation. We do not believe in the idea that companies can be boxed into categories such as "cheap" or "expensive." In our view, that is too simplistic of an approach. Valuation is but one of the factors that investors need to use when judging whether or not a particular stock has a place in their portfolio. But, even we have our limits regarding what we will pay for a stock. Attunity, however, does not surpass those limits, and its valuation is, in our view, far from outrageous.
On a pro forma basis, Attunity earned $0.24 in EPS over the past trailing-12 month period. Based on the company's closing price of $7.21 on November 12, 2012, that gives the company a P/E ratio of 30.04x trailing non-GAAP earnings (Over the past 4 quarters, Attunity's GAAP EPS has been impacted by several one-time charges, including taxes related to its acquisition of RepliWeb, as well as amortization of acquired intangibles). A P/E ratio of 30 is not outrageous considering that Attunity is growing its revenues at over 70%.
But what about its GAAP P/E ratio? Surely the company is overvalued on that metric. With a GAAP P/E ratio of 240.33x trailing 12-month earnings, Attunity may seem like a stock to be avoided at all costs. But, it is important to remember the following fact: while Attunity has been profitable on a non-GAAP basis for some time, it has only recently made the pivot to GAAP profitability, and that is inflating its GAAP P/E ratio. That being said, we are confident that Attunity will achieve sustainable GAAP profitability as a compelling product portfolio and a solid market position gives the company ample room for growth. We turn now to that market position.
When Politics Matter as Much as Products
A company's success comes from more than just how innovative its products are. While innovation certainly plays a major role, market positioning and dynamics can impact a company just as much as the quality of its products. And Attunity happens to be well positioned on both the quality front and the market front.
In the world of technology, corporate politics matter just as much as products, and in an era where IT companies are becoming more and more "horizontal" (our term for the practice of trying to be a one-stop shop for a customer's technology needs), neutral companies are becoming harder and harder to find. Attunity, however, has remained neutral in an increasingly competitive environment, and it has inked deals with some of the largest technology companies in the world. Attunity's partner list includes Microsoft (MSFT), Oracle, HP (HPQ), Amazon, IBM, Dassault, and Savvis [a subsidiary of CenturyLink (CTL)].
Attunity has shrewdly chosen to partner with the industry's leading players instead of fighting against them, and by giving its technology strategic value to each of its partners, the company has positioned itself for future growth and success. Innovation is certainly an essential component of success in the technology sector. But corporate politics has a major role to play as well, and Attunity has worked hard to secure its position on both fronts.
We fully believe that Attunity's best days are ahead of it, and think that investors who add to or initiate positions in the company will be rewarded in the long run. Attunity is an under the radar investment in the continued growth of data around the world, with what we believe is a reasonable valuation and a stable balance sheet (one that we think will strengthen over time). Attunity is well positioned to meet the needs of both its partners and its customers, and by doing so, it will likely deliver solid profits to its investors.
Additional disclosure: We are long MSFT, IBM, and AMZN via the Fidelity Growth Company Fund. We may initiate a long position in Attunity over the next several trading days.